Reserve Bank Governor Don Brash commented: “We believe that business
confidence is set to strengthen, consistent with economic activity having picked
up in recent months and being noticeably stronger in the second half of the
year. Even with some exchange rate appreciation and slowing in world growth,
exporters and those competing with imports will continue to benefit from
exceptionally good trading conditions for some time. And the reality is that
there is not much spare capacity in those sectors.

“We believe that the pressure on resources associated with the
resurgence in growth can be kept in check with a gradual and – by
historical standards – rather small firming of interest rates next
year.

“It is also clear that, in the short-term, annual CPI inflation will
exceed the top of the target band for the next several quarters. Even so,
stripped of the transient effects of international oil prices and cigarette
taxes, CPI inflation will remain well within the target range. In accordance
with our longstanding agreement with Government, the Bank will continue to focus
on the persistent elements of inflation and therefore ignore the transient
elements.

“Inevitably, our confidence that the temporary inflation spike will not
become persistent is affected by the wider situation, including the degree of
pressure on the nation’s resources. While there are clearly some risks
that inflationary pressures will turn out to be stronger than now expected, at
this stage we believe that a small firming of interest rates next year should be
sufficient to ensure that the current spike in inflation will prove
transitory.

“In summary, somewhat higher interest rates are likely to be needed,
but not quite yet. The extent of the increase will depend very much on how the
world economy evolves, on how the economy responds to the stimulus provided by
the low exchange rate, and on the response of price and wage setters to the
near-term increase in the inflation rate,” Dr Brash concluded.

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